What could digital blockchain do to oil and gas?

31 Oct What could digital blockchain do to oil and gas?

You’ve no doubt heard about bitcoin, a cyber currency based on a technology called blockchain? Well, there’s so much more to blockchain than currency, and it will eventually have a pretty dramatic impact on aspects of oil and gas. Curious? Read on.

What exactly is blockchain?

Blockchain is a digital solution to one of modern society’s basic problems – that we can’t always trust everyone, or that we shouldn’t.

Think about it – when we buy houses, we have to retain lawyers in the middle of the transaction to file all the necessary paper work and keep all the parties honest. That’s an extreme example, but there’s low trust in simpler kinds of transactions like buying things. That’s why buyers issue purchase orders, shippers issue packing lists, sellers submit invoices, and banks release funds, all of which are wrapped up in agreements, contract terms and numbering schemes that enforce tracking, delivery and payment.

Our privacy laws and confidential information rules are all linked to this question of trust. The whole notion of a privacy law is predicated on the lack of trust between parties, and the risk that one or the other might reveal some confidential information when it suits them. Will I hand over my health records to a hospital if I think they might hand my state of health to my insurance company?

We all have some horror story we can tell about some deal that fell through because the trust was there but not the verification (Bernie Madoff). We build elaborate mechanisms to verify the relationship, overdoing it for some and underbaking it for others.

With the power of global telecoms networks and cloud computing, some bright spark came up with a nifty way to create highly trustworthy shared information, and called it block chain. A block chain is a shared ledger, structured and encrypted in such a way that it is very hard to subvert. Ledgers are duplicated sets of documents (a block of documents in a chain) housed by any number of participants in some kind of business relationship. Documents can only be added as a block to the chain (or existing blocks changed) if all the participants agree. This makes the chain very hard to tamper with because so many parties are involved.

Why bother with blockchain?

The reason for using blockchain is because it represents an opportunity to dramatically lower cost and reduce misunderstandings, disputes and fraud. A not insignificant amount of overhead in a standard company is devoted to the various means we put in place to assure trust with counter parties and to minimise the costs of eventual misunderstandings, disputes and frauds. This includes writing and tracking all the outside contracts we have in place, the reporting we do for compliance and the monitoring we impose on ourselves and on our service providers. And all the associated paperwork.

Not only is the volume of such tracking and compliance accelerating, the people hired for this job are higher skill and higher cost than the clerical staff of the past.

This burden has been growing dramatically. An economics outfit in Australia calculated that for the Australian economy, the entire gains from reducing clerical staff over the past decade have been more than offset by the addition of new checkers and trackers.

It’s a drain on productivity and an inflator of cost. If there’s something oil and gas does not need right now, it’s business practices that lower productivity and increase cost.

Who is using block chain today?

There’s heaps of developments going on in blockchain because there are so many places in society where counter parties transact in a relationship that is characterised by low trust, and the pressures to improve cost and productivity are intense. Two leading uses are in banking and healthcare.

Banking is a leader because banks exchange funds with each other as they settle transactions (buy and sell agreements) between their various customers. Banks wire each other money through exchanges or directly to settle a transaction. They wrap complex systems and management mechanisms around these transactions to make sure the dealings are honest. I can imagine entire bank departments full of compliance checkers, contract writers and verifiers, accounts and lawyers whose roles are to make sure the transactions happen as they are supposed to. Banks generally don’t like the exposure that comes from getting ripped off because a counter party won’t honour a deal.

During a disease outbreak (Ebola?) hospitals and government agencies will begin to assemble data about the intensity of outbreak, locations and hotspots, strains of disease, rate of spread, hospitalisation rates, mortality and so on. Privacy laws prevent this information from being released, and so social response is delayed. But if this information could be released in a form where privacy is protected, it could help accelerate social solutions (immunisations, treatments, medicine delivery). That’s where block chain comes in. Blockchain technology allows this private health data to be published but in a format that protects the privacy of the source of the information. The data cannot be used, copied or shared without the blockchain.

Why oil and gas?

In my view, the oil and gas industry presents a particularly compelling opportunity to leverage blockchain because there are so many places in oil and gas where counter parties have low levels of trust, where the stakes can be high (that is, the value at stake can be substantial) and where pressures to reduce cost and improve productivity are intense.

Where could blockchain work in oil and gas?

Here’s a handful of ways blockchain could be pressed into service in oil and gas:

Land transactions. Oil and gas companies need to acquire rights to access land to prospect for, explore, appraise, and then produce oil and gas. The counter parties are often individual land owners who have limited exposure to oil and gas and may be outgunned in land dealings. There’s even a phrase “shady land deal” to describe this process. Blockchain could be used to verify and eliminate fraudulent land dealings.

Oil and gas sales. Oil and gas is sold in large volumes and as such entail significant value, not unlike the size and scale of transactions between banks. The frequency of transactions is manageable. A 300k bbl/day oil refinery will need to source a very large crude carrier every week to maintain adequate volumes, and those cargos can cost as much as $100m (2 million bbls at $50/bbl). Oil companies also need to be aware of who they are sourcing from – some exporting nations are from time to time under sanctions to prevent trade in this commodity. Blockchain could ease oil sales in the same fashion that it is facilitating banking transactions.

Complex sourcing. Oil and gas contracting can be complex with very lengthy contracts and agreements. For one of my own projects in Australia, the typical length was in excess of 80 pages, for work that might only last 20 days. It’s very typical that a contract is adjusted by a change order that needs to be tracked. One LNG project that I worked with was faced with the problem of contracts dating back years to the original project start date, but not in force until the LNG shipments started. All manner of inconsistencies began to crop up and it wasn’t clear what contract was in force over what situation.

Capital projects spend. A major capital project in oil and gas could be $20b, spread out across 5 key EPC contracts, and extending down to dozens of other purchase and sale agreements. Attention to the contract is key to make sure that suppliers don’t substitute where they shouldn’t and that the contract terms are being honoured. What would be the savings from the various lawsuits in the industry where operators and EPC firms have to settle their disagreements about the contracts?

Joint ventures. Oil and gas company ventures are another block chain candidate. The ventures are comprised of complex agreements that need to withstand the ups and downs in the industry, and are the basis for the sharing of costs and revenues from the venture. Most have audit clauses in them giving the parties the rights to audit each other to make sure that all are in compliance with the contract. Imagine a scenario where these audits are not necessary?

Service contracts. I worked on a service company bankruptcy file this year. For months, the operator gave verbal istructions to the service company for changes to work, which were not papered. The service company ran out of money and attempted to collect for these verbal orders, only to be told that the verbal instructions were not contractual and therefore not collectible. All of the subcontractors were also impacted. Where was blockchain that day?

Blockchain technology is coming. Companies in oil and gas need to:

Get smart on this technology and how it might impact the industry.

Participate in the various working groups exploring blockchain and its deployments.

Launch a trial with some existing trusted business partners to learn how it works and the value it can create.